Sunday, December 2, 2012

Evening Echo 28/11/12

The text of a recent article for The Evening Echo is below the fold.

The last year in which the government’s accounts were in balance was 2007. In that year, both government revenue and government expenditure were around €68 billion, but as we know with hindsight this position was very fragile.

This year is the first year since 2010 that direct payments to the banks will not form part of the deficit. The deficit this year will be almost €14 billion, the gap between government revenue of €56 billion and government expenditure of €70 billion.

Compared to 2007, it is evident that the deficit was caused by a collapse in tax revenue. The level of government expenditure is slightly up on 2007 but government revenue is down significantly. This is the hole created by the stamp duty, capital taxes, VAT, and income tax which was pouring into the government’s coffers from the construction and property sectors.

Most of this money was borrowed money. From 2004 to 2007, the impact of bank lending was to pump an average of €3.5 billion a month into the economy and about a third of this found its way to the government.

The only way to close the deficit is for expenditure to fall and/or taxation to rise. In good times, a country could watch as economic growth would do a lot of the work. Early plans to close the Irish deficit were predicated on a strong return to growth within two years. However, as 2009 became 2010 and 2010 became 2011 the return to strong growth was, and still remains, two years away.

With the precarious state of the public finances the only way to close the deficit is through explicit expenditure cuts and tax increases. Next week, ministers Michael Noonan and Brendan Howlin will present a budget which will include €3.5 billion of budgetary adjustments.

It should be noted that this adjustment to take money out of the economy over a year is equivalent in size to what the banks were previously pumping into the economy in a month. The Irish economy is not in the ruined state it is in because of austerity. The Irish economy has gone cold turkey because it has lost the monthly adrenaline shot of a €3.5 billion monthly injection of bank lending.

Ireland’s budget deficit opened in 2008 and by 2015 it is envisaged that it will still be around €5 billion. Over this period, the excess of normal government expenditure over government revenue will add around €100 billion to the national debt. We have poured €64 billion into the banks, but face the prospect of getting at least some of that back.

The borrowed money that has been spent on funding public sector pay, social welfare, government services as well as the interest on money borrowed for previous deficits is gone forever. Since 2007 we have built up a huge national debt. Most of this has been because the deficit. The deficit must be closed.

Next week’s budget will be another step in that direction. People will argue about the measures being introduced but there is no argument over the need to close the deficit.

One approach to take would be to try to do so through taxation. The problem is that there is no pot of money out there just waiting to be taxed. We have a €14 billion deficit. In the run up to the budget there have been proposals from elements of the opposition that suggest that taxation along can bridge the gap. It can’t.

There is an uncosted Sinn Fein proposals for a wealth tax which uses very unsteady assumptions to argue that €800 million a year could be raised. The Socialist Party have examined the benefits of increased income taxation. One of their costed proposals is for incremental increases in the rate of income tax on very high earners up to 78%. Analysis presented by the Minister for Finance shows that this would only raise €850 million.

There is the potential to raise additional tax revenue from the wealthy and the high earners but they can only every go a small way towards addressing the huge deficit we face. The Sinn Fein wealth tax would be applicable to fewer than 15,000 people while the Socialist Party tax increases would be applied to just over 5% of earners. After these taxes have been introduced the bulk of the deficit will remain.

We can try to raise a lot of money through large tax increases on a very small number of people but the reality is that more revenue will be raised with small tax increases on a very large group of people. Next week we are likely to see lots of small increases in tax rather than one big taxation measure.

The biggest will likely be the property tax which will aim to raise an extra €300 million on top of the money collected by this year’s temporary household charge. This will be around €200 per household. There will be some changes to excise duties such as cigarettes and motor tax.

Although changes to income tax have been ruled out, there may be some changes to the Universal Social Charge which is an income tax in all but name. Other changes will include reductions in pensions reliefs and increases in capital taxes but the gains from these will be relatively minor.

All told, around €1 billion of new taxation measures will be announced. On the expenditure side there will be more than €2 billion of cuts and this is where most of the interest will lie.

There will be debate and arguments and the reason for this is that we still have autonomy over the particular measures that are used to reduce the deficit. The EU/IMF have set deficit targets but they don’t dictate how those are achieved. They simply want to see Ireland get back on a sound macroeconomic footing.

Ireland is making steady, but slow, progress in emerging from the carnage left behind by mismanagement of the economy culminating in bursting of the property bubble. Next week’s budget can be another step in this direction.

There will be difficult, and unpopular, choices. Few politicians want to be increase taxation and reduce expenditure. The current government knew what they were getting into when they joined forced in early 2011.

We cannot avoid the pain of closing the deficit and the best we can hope is that they try to choose the right balance between workers, retirees, students, employers, the unemployed and the infirm. It’s not easy but we’re getting there.